Microcap growth attractive for investors

Microequities Asset Management chief Carlos Gil says small businesses are attractive for investors because of their growth potential.

Transcript

TICKY FULLERTON: One of the attendees at the conference today was Carlos Gil, chief executive officer of Microequities Asset Management, which started life in 2005 as a dedicated investment research house in Australia focused only on microcaps. And he joins me now.

Welcome to the program.

CARLOS GIL, CEO, MICROEQUITIES: Thanks for having me.

TICKY FULLERTON: This is an area I suspect our viewers will be very interested in. You call microcaps under $250 million market capitalisation. What is it that is attractive from an investor's point of view? Is it really the sort of high growth, high risk aspect?

CARLOS GIL: For us it isn't. We're very conservative in terms of the companies we decide to invest in. There are two real elements that attract us to the asset class. One is we think the growth outlook for the majority of the microcap companies tends to be far superior to the mid cap or the large cap counterparts. We also believe there is much more market inefficiency in this part of the stock market.

TICKY FULLERTON: For which read mispricing.

CARLOS GIL: There is not a lot of institutional support for microcaps.

TICKY FULLERTON: Because it's not worth their while?

CARLOS GIL: The economies of scale for a research department in most brokerage and investment bank houses, the reality is that it's a cost centre. So they have to that analysts might cover six to 15 companies. They're typically in the high salary. The research department of an investment bank or a broker is the cost centre, so somehow, some way, the broker of the investment bank must deliver a revenue side to their business that supports and funds that research cost centre.

TICKY FULLERTON: So you say you're a conservative fellow. You have got your research behind you. For the average retail investor, do they need to be a sophisticated investor to look at these sorts of stocks?

CARLOS GIL: We don't think so, but they definitely have to be aware of that investing in a microcap company necessitates a systematic approach of fundamental analysis before they go out. There's a wide disparity in terms of the investment quality of a lot of the microcap companies. We're very passionate and firm backers of the asset class and a lot of the microcap Australian companies but the reality is we look at a lot of companies that don't have a genuine investment case.

TICKY FULLERTON: For every Big Air there's presumably a hot air company that might've crashed. Presumably there are some ASX 200 companies that grow to become microcap companies?

CARLOS GIL: That's right. To give you an idea we have a high conviction, our deep value microcap is a high conviction fund. We have only 15 businesses that we own. There are roughly around 1,500 microcap companies. For every company we've decided to invest, we notionally reject 99 companies.

TICKY FULLERTON: Going to your deep value microcap fund, that was launched very cleverly on March 6, 2009. Since then you've had a return of over 100 per cent compared to the All Ordinaries of 68 per cent. This last month and indeed the last couple of months you were well below the All Ords in your return. Did a lot of that have to do with you've only got those few stocks? One position you've had in particular accounted for that difference?

CARLOS GIL: We have our top value, our highest weighted position is roughly 16 per cent of our total funds under management. How we derive value is based on an intrinsic value. We don't believe the market is an accurate valuer over the short to medium term. We firmly believe all our 15 companies are considerably undervalued, including Big Air.

TICKY FULLERTON: You pick winners?

CARLOS GIL: We pick winners. Over the short term we absolutely recognise that we might have under performance over the short term. What we are absolutely convinced on is that over the medium to long term and every time we buy into a business we're always strategically looking at a business from a three-to-five-year perspective, is that we should be able to deliver consider out performance over the All Ords accumulated index.

TICKY FULLERTON: What sort of business models do you look at and do you speak a lot to management, presumably management of small caps have more time to talk to you?

CARLOS GIL: They do and in any business we believe that management is an integral part of investment outcomes. We look at the fundamentals of the business first and foremost. We don't invest in unprofitable businesses. We need at least two years of profitability is a minimum filter criteria. We look at where we think the business will be from a strategic perspective from three to five years. Are the underlying growth metrics of the industry favourable? And lastly but not leastly the quality of management. We decide we take two key criterions in terms of the management. Are they good business leaders and are they ethical and moral compass aligned to the underlying shareholders' best interests?

TICKY FULLERTON: What about sectors? You say you have to have two years of EBITDA (earnings before interest, taxes, depreciation, and amortization). All these small cap, microcap mining companies I notice under six per cent of your whole investment is mining and 37 per cent software.

CARLOS GIL: Yes.

TICKY FULLERTON: Would that be what you'd would suggest more broadly to retail investors to look at that? After all, this boom will be a long one on the mining side

CARLOS GIL: We would agree with that we feel uncomfortable taking commodity risk. We feel taking more comfortable taking investments in companies that service the miners. Essentially a commodity you have no control, you have no pricing power. You're essentially driven by the supply and demand equation of that underlying commodity. Service providers have different price pressures and price controls over their services, so we feel much more notionally comfortable taking stakes in service providers to the miners.

TICKY FULLERTON: Very quickly, as a microcap company, how do I attract you as a fund manager?

CARLOS GIL: Having a very good business that's profitable, that's got a great growth outlook and having a competent and honest management time behind it.

TICKY FULLERTON: Thank you very much for joining us on Lateline Business.